Slowdown in Canada Brings Even Odds of Recession Next Year

Most forecasters expect that growth in Canada will accelerate during the next few quarters. But a more sobering view comes from Montreal-based economist Peter Berezin at BCA Research.

A slowdown is on the way and there’s a 50-50 chance of recession in Canada by the middle of next year, argues Berezin, managing editor of the monthly newsletter The Bank Credit Analyst.

Growth is likely to falter as the housing bubble deflates and as investment spending slows, especially in the natural resource sector.

If that happens, the Bank of Canada would have limited recourse to stimulate the economy with easier monetary policy since interest rates are already near historic lows.

In these circumstances, the Canadian dollar is likely to weaken during the next year while Canadian stocks are likely to underperform.

Canada, he says, shares many of the same characteristics as other medium-sized resource economies such as Australia and Norway. All three have overvalued housing markets, high levels of household debt and overvalued currencies.

Canada may simply be at the leading edge of a broader story that will play out over the coming years, in which smaller economies begin to suffer the ill effects of global financial conditions that, from their perspective, have been too loose for too long. – Peter Berezin

This would represent a sharp reversal of the trend in recent years in which Canada has outperformed many other economies. Our banking system was stronger after the financial crisis of 2008 and our governments were in better fiscal shape.

Most forecasters have continued to be reasonably optimistic about Canada in the short term, pegging growth at more than 2 per cent in 2014. The consensus view is that Canada will benefit from the recovery underway south of the border.

That’s wrong, argues Berezin. Canada has a 50 per cent chance of slipping into recession, even if U.S. growth does accelerate.

The main culprit will be a weakening housing market in this country, which until now has attracted new construction investment and helped to sustain consumer spending.

Recent declines in home sales are just the start of a likely slide in prices that could be painful. “Relative to disposable income, house prices stand nearly 40 per cent above their long-term average,” he notes.

And Canadians are dangerously exposed to household debt. By one estimate, 30 per cent of mortgage holders would encounter serious problems in making their monthly payments if rates were to rise by two percentage points.

A housing bust in Canada wouldn’t be as dramatic for our banking system as what we saw in the U.S., but it would have a severe impact on consumption, because of the willingness of Canadian households to take on more debt by using their homes as collateral.

So, if Canadian home prices were to decline by 20 per cent over three years, household wealth would take a $400-billion hit and leave Canadian consumers far less willing to spend.

Along with a slowdown in natural resource prices, Canada won’t benefit so much from a recovery in the U.S. One reason is that the Canadian economy is much less leveraged to the U.S. than it used to be.

In the past, U.S. and Canadian GDP have tended to move in lockstep, but now there are signs of decoupling. Canadian exports of manufactured goods to the U.S. have been on a downtrend for more than a decade.

In 2000, exports to the U.S. of manufactured goods, machinery and transportation equipment accounted for nearly 20 per cent of Canada’s GDP, but today, that has slipped to 8 per cent.

If you want more proof, consider that employment in Canada’s auto industry — usually a bellwether for trade to the U.S. — has shrunk by 30 per cent since 2000.

“In any case,” says Berezin, “it is not clear that Canadian manufacturing firms could easily increase production, even if they wanted to.” Manufacturing capacity has declined during the past decade in line with falling output.

And there will be no manufacturing renaissance north of the border until this country does something to reverse its long slide in competitiveness.